It's finally Friday, Community! My favorite day of the week for many reasons; one of those being that I get to share a handy small business article with you all. Today's article was found on purewow.com and covers what is a good debt to equity ratio. And honestly, this is just good info to know, whether you're a business owner or not. Let's go ahead and jump right in...
What is a debt-to-equity ratio? This particular ratio is obviously comparing how much debt you have compared to your equity. The debt-to-equity ratio is often referred to as the D/E ratio which "looks at the company’s total debt as compared with its total equity." Whatever number you come up with could suggest whether or not a person or company has the ability to repay it's debts. With that being said, a low D/E ratio could work in your favor, showing that you are financially stable and have resources available on standby should you need them for an emergency. However, a high D/E ratio is most likely an alert showing "your debt outweighs your company’s ability to generate its own capital or turn a profit."
What is debt? A lot of times debt can be associated directly with credit cards or something like a student loan, but in this particular case debt is referring any liabilities you've taken to run your business. This is important to remember especially if you're just starting out; you do not want to stack up a large sum of debt before profit even has a chance to start. Remember, debt can be as simple as money you borrowed from a friend. You still have to pay it back some time.
What is equity? Equity is the value you have of cash, property, equipment, and other assets, after you subtract your debt and liabilities. The article mentions a flower shop business where to owner bought the storefront for $250,000, with $150,000 down. They had to take out a bank loan to cover the remaining $100,000. That makes the total debt (in regards to real estate) $100,000 and the equity $150,000. Which means in this case, the ratio is .67.
What is a good debt-to-equity ratio? Ratios vary and can be determined depending on your industry. The best way to explain this is mentioned in the article which states, "For instance, the average D/E ratio for S&P 500 companies (like Lowe’s or Domino’s Pizza) is typically 1.5. But investors in financial industries can expect a D/E ratio that’s 2.0 and above. Small or service-based businesses—like that flower shop—probably want a D/E ratio that is 1.0 or lower, since they have less assets to leverage."
I recommend checking out the article for even more info like how to calculate your debt-to-equity ratio and how it can help you interpret your company's profitability. I hope this post reminds you of this ratio that's good to keep in mind. Or maybe it made you see some areas that need adjusting to make your D/E a little better. Either way, we'd love to hear your thoughts! Have a great weekend everyone.